Good Intentions Hijacked
By Thomas N. Tripp 

(This article was written after investigation of the circumstances with regard to the 2008 financial meltdown in the U.S. that spread around the world, and in response to the many, many opinion pieces, editorials, books, articles, etc., almost all of which got the causes wrong, and therefore the solutions wrong as well.)

There is an insidious virus that infects politics as invariably as ice cream appears at Fourth of July picnics: supposedly well-intentioned officials think up schemes to make the world better while simultaneously enhancing their electoral careers-all at someone else's expense. Their designs require government to intrude on the lives of citizens who are viewed as incapable, insensitive, or intractably downtrodden.

The cycle-for it returns as persistently as winter's flu-was noted by Nobel Laureates Milton Friedman and Friedrich von Hayek: good intentions are elevated to statutes (with fanfare and self-congratulation); unfortunate yet unintended consequences abound as the artificial laws interfere with the immutable commands of economics or social interaction or human nature. The negative results are so destructive that additional legislation is enacted to fix what the first fix broke. The supplementary laws not only do not repair either the first problem or its unintended consequences, but create added complexity that spawns further legislation, administration, regulation, even judicial intervention, ad infinitum (and, of course, funds taken from taxpayers to pay for all these good intentions).

The pretext for such incursion is fairness, or social justice, or equality; its energy is found in political correctness. Thus the political class thrives but the fate of the Republic is left in doubt.

Those who stirred the pot in the U.S.'s subprime mortgage drama, who now intentionally disguise their own malfeasance, are the Congressional rogues and their mainstream media toadies, all of whom are currently engaged in widespread distortion and disinformation to cover their culpability. This financial fiasco and its resultant world-wide economic chaos are the result of astoundingly bad political and economic judgments.

The politics of the subprime meltdown are primarily the politics of Washington, not Wall Street. The financial operators became complicit, but even those actions were hardly voluntary. The elected players, by means of guerrilla warfare, politically overwhelmed so many aspects of the mortgage industry, the banking industry, the regulatory agencies, and the U.S. economy that the size and import of the effects they wrought can be too easily used to camouflage the causes. Although the economic results of the political carpet bombing and endemic corruption of the period 1990 through 2008 surface at many points in this presentation, they are decidedly not the main point. If we don't keep the causes and the trigger-men to the forefront, two bad things happen: first, we will not comprehend what went wrong so the next time temptation arises we'll miss that as well, and, second, we will be much longer in resolving the economic consequences with which we are faced.

The media can set the terms of debate and then sensationalize it with very little effort. Once they begin on that course, and they do that as we know because sensationalism is what sells (in this case the devastating results that have flowed from political corruption) it is difficult for the public to get back to where the story began. Today the sycophant media and the elected players are burying the political foundation of the economic passion play that has resulted in fiscal chaos. If the public focus is kept on the resultant harm then blame can be rated and solutions that are worse than the efforts at social engineering at the core of these situations can be imposed. These phony actions not only don't solve the problem but keep the malefactors in the limelight-no matter their guilt-as the so-called saviors of the Republic.

It is unfortunate that the efforts of the Washington media/political team have now reached proportions that render risible ordinary adjectives that attempt a measure of magnitude in describing what happened. Contemptuous superlatives cannot scale the protective wall being erected around the most culpable. The only way to combat the not unexpected collapse of journalistic integrity is to return to the facts and the motives of those who directly instigated what we are experiencing. Facts are stubborn things, and useful tools.

Capitalism, Media, Power, and Politics

The good intentions underlying the history of political interventionism recur too often to ignore-they are the seductive vamps that line the corridors of power. Obviously, bad results are no stranger to these often grand schemes. The subprime mortgage mess and its myriad social and economic costs are Exhibit One in this indictment. There are those who claim the mess is so big only government can solve it. But, as the effects of twentieth-century public policy actions have proven, that is habitually the wrong answer.

There is a player that is far bigger than government, certainly more rational, and far less corrupt or scornful of the human participants, that can "solve" the mess: the free market. This is a free market with internal rules-in other words, it is constrained by reality, not let loose to practice political self-interest as the government's multi-trillion dollar stimulus and bailout plans have done. In 1776, when Adam Smith published his seminal work, An Inquiry Into the Nature and Causes of the Wealth of Nations, he explained how these rules are formed through "enlightened self-interest." The market runs on experience, learns from mistakes and is based in the idea that the sum of all activities results in success and failure. Government lacks all these tools. What is imperative as we sort through the current morass is that we not blame the wrong factors or actors, or implement the wrong solutions. If we do we will neither solve today's reality nor prevent tomorrow's best objectives from becoming even more nightmarish than we currently imagine. In other words, the law of unintended consequences will throttle us if we are not careful.

Those of an anti-capitalist bent are determined to blame our situation on the system itself, Wall Street in particular. They grab the headlines in sympathetic media outlets because they can, not necessarily because they are correct, or even know what they are talking about. Their standard refrain, as they castigate the open market, appears again and again: "All we are trying to do is the right thing, which the market, because it has no empathy and is controlled by greed, will not do."

They use the word greed as much and as often as possible. In so doing they intentionally avoid investigating the middle ground between the universal alms giving they exalt and the pure avarice they insist is ever-present. The middle ground is where enlightened self-interest lives. If capitalism was really greed-based it wouldn't work-and everyone knows that. Those who live and work in free circumstances-in an open society-understand that they can only do well by meeting the needs of their customers. The literally billions and billions of free market transactions that occur daily just in the United States is a testament to the universal comprehension of how the system works-where both parties to transactions believe and actually are satisfied once a trade is completed. The only time the system becomes skewed is when the politically correct substitute their judgment for that of the participants.

When those distortions cause the system to begin to fail the intentions of the anti-capitalists are three-fold: first, to deflect the public's attention from their own enormous but supposedly well-intentioned failures (the well-intentioned label somehow makes their malfeasance excusable); second, to appear, through emotional indictments, to know what they are doing so they will not only be allowed to "fix" things, but will be begged to do so as they save the country from bad people; and third, they intend to heap blame on capitalism-an open yet amorphous, multifaceted, and complicated system, and thus convenient target-so they can garner credit that is both unearned and that offers a dangerous misrepresentation of what happened as they destroyed the system in the first instance.

"Capitalism is Dead," "The End of Market Economics," "The Fallacy of the Ownership Society." From the gallery it appears that only a fool or a knave would be anti-capitalist in the twenty-first century-but that doesn't stop people from making foolish claims or knavish accusations. They do that mostly to gain attention-again, because they can, and like most human beings they seem to need to do that. They also can because the public lets them. Rare is the article that takes the mess apart and offers ideas on how to circumvent repeat performances. Finally, there is always the effect of mob psychology-if everyone is blaming capitalism one might as well get on the band wagon or appear ignorant. Investigate? What? The facts are already in the public domain, all we need do is beat the horse dead to make sure not even a whisker twitches again.

An article about the banking industry in Newsweek (February 23, 2009) is a useful but wearisome example of how the wrong players are singled-out and pilloried in pure ignorance. It begins with hyperbole: "Public anger at financiers is at levels last seen in Moscow circa 1917." When discussing how poorly the large banks are at public relations the author notes "It's an example of how the well-heeled heels…flunked Risk Management 101." Except the banks didn't fail risk management tests, they were forced-not asked, not enticed, not begged-to ignore free-market rules through massive bad judgment by the political mavens in Washington, officials who didn't have an idea of what they were doing, but had the power to do it anyway.

If you read the Newsweek article and many like it, it is only capitalists who failed us. Never is the phrase "political assassination of the U.S. economy" even mentioned, much less investigated. The economic wisdom of Congressman Barney Frank is quoted. He observed, when commenting on how disgusting it is to have to deal with malfeasant bankers "We have no option if we are to get credit flowing in this country other than to work with the existing institutions." This from the man who almost single-handedly ensured the subprime meltdown would be fantastic and who supported subversion of the capitalist system from the beginning (Cong. Frank will reappear later). Finally, the article notes that "…people who have done well in finance tend to think they're really good at everything" as though no other group of human beings has ever fallen prey to such hubris in their own fields-like journalists, editorial writers, and least of all-politicians.

The history of the world's economic progress has been substantiated in numbers that make the mind swim in Lake Euphoria. Literally billions of people have been lifted out of socialism and poverty since the end of the Second World War. They haven't all been lifted to the level of a ranch house in Omaha or a new Ford, but they are also no longer abjectly poor. Their lot improves measurably, annually. There are billions more for whom capitalism will be meaningful when the yoke of good intentions is lifted.

More importantly, the reason most of these people experience continually rising living standards is that they live in freedom, the necessary foundation of capitalism. No other economic system than capitalism can begin to claim this level of progress, much less really do it. If you want names and numbers on how and why this occurred, read The Commanding Heights by Daniel Yergin and Joseph Stanislaw, or surf the Internet using virtually any keywords that describe economic success. If capitalism and individual incentive aren't here to create wealth does anyone really believe government regulators and politicians will be able to? Yet that tired prescription, minute government oversight and control by politicians who, because they've been elected think they're really good at everything, economics in particular, is exactly what is offered. The free market is dismissed.

The material that follows isn't directly about what has been achieved through capitalism's rules and discipline; the progress is mentioned only to set the stage and begin from a different point than the headlines and Congressional doomsayers offer. It is a plain and unfortunate fact that popular news outlets, whether broadcast or print, often claim they do not have the time to look at history and facts (a task called "due diligence") or the space to present the details (within which the Devil always lies), but what they are really saying is that the reading/watching/listening public does not have the attention span or will to wade through helpful, even pertinent materials. I respectfully disagree.

Serious print publications and the Internet are exactly where the type of analysis and factual presentation offered here can have its biggest impact. Understanding how matters occurred or what questions we now need to ask are important elements in avoiding repeat performances. If the discussion about the subprime debacle is co-opted in the mainstream media, with its own commercial and political agenda, the truth can be and is manipulated and distorted, and often finalized beyond recognition or debate. Media's false conclusions mean corrective measures based on those conclusions cannot possibly mend what's broken.

The Genesis

Throughout the subprime mess many of the historically molded fundamentals of free-market capitalism were politically undermined: risk assessment, fiscal discipline, individual responsibility. Many sound mechanisms were likewise shoved out of the way. The market was almost brought to its knees by political meddling in government oversight and regulatory functions, not by free market mechanisms or capitalist greed as has been contended to the point of becoming a mantra. We can make no mistake about the premise: capitalism created the wealth that government tinkered with. It emphatically was not the other way around. It is the tinkering we need to understand so we can comprehend how the distortions of both our economic system and our government, implemented by the politically correct, have had such a profound effect.

As has become apparent, the genesis of the failed home mortgages that have caused so much trouble is the Community Reinvestment Act (CRA) of 1977. This was the political opening, the good intention that allowed government to become so heavily, and heavy-handedly, involved in America's housing and lending industries. What the act proposed to do was, first, limit banks in their efforts to collect deposits in poorer neighborhoods but not reinvest them there, and, second, stop the practice of "redlining," that is, the literal drawing of red lines around neighborhoods where bank proprietors had determined they would be reluctant to make mortgage loans. That didn't mean they didn't make loans, but they did make proportionally fewer loans in those areas.

Many of those neighborhoods in large urban areas were home to black residents. However, the banks were not discriminating against blacks, but against risk. This is an important and critical point. This reality will be hotly contested, even dismissed by the politically correct, but its historical and economic basis is easy to demonstrate.

Understanding risk imposes discipline on lenders. By the middle of the twentieth century there were plenty of banks that made mortgage loans in black neighborhoods-whether to individual home or business owners or to investors who rented to black enterprises and residents. The money for homeownership and private ventures in these areas had to come from somewhere-all those buildings and companies weren't paid for in cash-and it came from banks that knew the neighborhoods.

But what happened more and more as the black population in cities soared after World War II was that financial uncertainty rose proportionally because these new residents had not had the time to establish themselves as good credit risks, with sound, long-term jobs and repayment histories. This risk, not ethnic groups, or skin color, was and is what bankers avoid. Eventually it was easier not to loan with normal liquidity in economically depressed areas; ultimately the extreme practice of red-lining arose. Red-lining was defensive, and it did result in group-think or mob psychology, and without question it was wrong. That the "lines" were coincidental with black neighborhoods was a result of economics; race did not cause the practice, but minorities suffered for it. Red-lining went as far in one direction as mandatory subprime loan quotas went in another-both were bad for everyone.

The CRA was put in place during the Carter Administration. This was the heyday of Democrat control of both Congress and the White House, and the CRA came into being with every good intention that could be articulated. While the goal of Congress was to increase lending in poor and minority neighborhoods-its intention was not to force loans to un-creditworthy borrowers. The act said, when it came to mortgage lending, "look at the borrower, not just the neighborhood." It asked banks to engage in retail banking efforts-person by person. It was neither a bad nor impractical idea. In the aftermath of the Civil Rights Act of 1964, the Voting Rights Act of 1965, the Fair Housing Act of 1968, and the Equal Credit Opportunity Act of 1974 it seemed the times were more than ripe to foster home ownership for reasonably situated residents in the black community. The banks needed a push, the politicians wanted to help.

In offering the push the political class did not throw financial sanity to the wind. Those who created the CRA, Democrats all, still understood that money loaned somehow had to be repaid or the whole concept would eventually blow up in their faces (which, of course, it did thirty years later). So the act contained the following language to protect bankers from feeling forced to make highly risky outlays: loans shall be made "consistent with safe and sound lending practices." Safe and sound means a down payment (to establish the borrower's commitment), a job (to ensure the borrower can repay the loan), and a credit history (to demonstrate the new owner has a habit of being fiscally responsible beyond just being employed). That the safe and sound statutory language was forgotten in a thousand acts of political hubris at best, or intentionally buried at worst, led directly to where the U.S. is today. It was a process that first allowed, then forced acceptance of political judgment regarding economic matters.

The CRA was used, not abused, for a decade and a half-until in the 1990s Democrats in Congress and Bill Clinton in the White House wanted to make an issue, particularly for urban blacks, of homeownership. Clinton anticipated George W. Bush's "ownership society" by two election cycles. But there were other players in this game, and they took Clinton's apparent good intentions, and distorted them with his knowledge and complicity in a guerilla war that ended badly for millions of people. Ultimately, there were culpable folks on every side; few came away with no blame.

As this mess devolved to the fiscal catastrophe that has eventuated, it is necessary to recall that it is the taxpayers who always get stuck with the bill, and the citizenry at large that suffers the greater economic consequences. (The Federal Reserve announced during the second week of March, 2009 that American's net worth dropped $11.2 trillion in 2008.) Thus, this recap of the political and economic history of the subprime mess is intended for taxpayer consumption.

Community Organizers and Activists-Political Correctness from the Bottom Up

The wildcard players in the series of events and circumstances that brought the U.S. financial system to its knees were third-party groups that inserted themselves, with further good intentions, into the private mortgage business. There were several sizable players in this cohort, but two of the biggest were ACORN, the Association of Community Organizations for Reform Now <>, and NACA, the Neighborhood Assistance Corporation of America <>. These community activists, who were ultimately shown to be as ignorant and myopic as they were aggressive, pushed the politicians to make home ownership for minorities a political priority. And, in their view, the economics of this move be damned. They wanted to force banks to make loans and they contended the banks were not doing so solely because of racism. "We have to use every means at our disposal to end discrimination and to end it as quickly as possible," Clinton's comptroller of the currency, Eugene Ludwig, testified to the Senate Banking Committee in 1993. What he meant by "every means at our disposal" was using not just existing tools, but ones created virtually out of thin air; tools that had no sound footing in economics. (Barack Obama was an integral part of both the network of activists and the ideas they supported. His participation is noted to demonstrate that his experience and history should make him particularly well-suited to help resolve both the subprime mess and its larger political consequences. That that may not be the case, for too many reasons to iterate here, is unfolding as his administration takes the reins in Washington.)

Basically, through intimidation and politically correct blackmail, these organizations led the charge against banks and other lenders to expand loans to high-risk low-income mortgage borrowers. These activists threatened banks with then-available government restrictions and punishments that regulators were willing to support because of their own politically-correct views. That administrative rules could be used to prevent financial institutions from engaging in mergers and buyouts or to expand the geographic and industry reach of their business efforts until they agreed to lower underwriting standards was a most effective lever in this battle. Underwriting standards are the measures of creditworthiness by which every borrower is judged. If those tests reveal that a borrower is not financially sound, they are denied a loan for a simple reason-they are considered too great a risk to pay back the money being lent.

If the banks didn't immediately understand what was at stake, they learned in short order when groups like ACORN filed CRA complaints against them. These could allege, and sometimes demonstrate with flimsy or even bogus evidence, that banks were not doing enough to increase minority lending. That increasing lending beyond the basics of fiscal prudence might someday threaten the whole system was a concept truly beyond the comprehension of those on the attack.

The politically correct push in this instance was intended to offer access to homeownership to minority applicants with few resources and poor or non-existent financial history. This cohort became known as subprime borrowers. It wasn't that they were getting sub-prime-interest-rate loans, loans reserved for a bank's best customers, but that their applications were subprime, meaning sub-standard, in that they did not meet prevailing credit or repayment standards.

A question arises: how did the community organizers know which banks to target; who wasn't carrying their part of the CRA load? That too became relatively easy to discern after the U.S. savings and loan debacle of the 1980s. As a result of that series of events Congress passed laws requiring banks and savings and loan institutions to keep records of applications for mortgage loans-by race, gender, and income. That such measures did nothing to make the institutions themselves more financially sound or the borrowers more fiscally responsible was irrelevant; it was an opportune time as the S&Ls were dismantled, sold off, or bailed out, to get politically correct information as part of a "reform" movement. From these public records it was fairly easy to learn what the banks and S&Ls were actually doing. Any company that didn't meet the organizer's views vis-à-vis diversity or strict minority lending levels was targeted for investigation and scrutiny by means of the CRA. The intimidation factor was at its highest level.

The intentions of the community activists were not entirely altruistic-these groups earned payments for the loans made with their help. The fees were collected under the guise of credit counseling and mortgage loan application assistance. The activists had no responsibility for the loans themselves once they were issued, certainly no responsibility to ensure the borrower could repay the loan, but they did have an incentive to ensure the loans materialized-it was profitable. And, although non-profit organizations do not show earnings when their activities are reported on tax returns, they can still generate substantial revenue and yet avoid owing taxes by using their income to pay salaries (patronage jobs), hire consultants, and support myriad expenses for employees and managers. They also make political and other contributions. The bottom line for these entities that supposedly have a zero bottom line is that there was and is an incentive and a profit to be made in loans to subprime borrowers. The fees collected by means of the loans generated maximized the ability of these organizations to have more clout and allowed them to become more "persuasive."

The Dominos

The tangle that brought down the U.S. financial system's stability obviously started small. But because the players didn't understand what they were doing, or what they were causing, they moved blithely on, leaving hidden havoc in their wake. They were simply oblivious to the macroeconomic/long-term consequences of their actions. Banks ultimately wouldn't say "no" to the call for more subprime loans for fear the activist's co-conspirator regulators would label them racists and punish them. Fannie Mae and Freddie Mac didn't say "no" when these mortgages were deposited in their laps because the program was, among other things that will be discussed later, politically correct. (The formal designations for these two entities are the Federal National Mortgage Association [Fannie Mae], chartered in 1938 as a federal agency, re-chartered in 1968 as a private share-holder owned company, and the Federal Home Loan Mortgage Corporation [Freddie Mac], chartered in 1970. Freddie Mac's avowed role was to provide competition to the newly privatized Fannie Mae.)

Fannie's and Freddie's involvement in this sector of the mortgage industry was a core political move of the Clinton Administration. These two semi-public entities were big enough to buy most of the subprime mortgages, and we'll see later how they were forced to do so. Unfortunately, the financial markets didn't have a clear understanding of what was happening at the community level where myriad subprime mortgages were made and then bundled in packages. Ultimately there was little transparency in these financial instruments. Initially the returns to the eventual purchasers of these securitized mortgages were both attractive and solid-partially because they were supposedly backed by the full faith and credit of the United States Government, even though they actually were not, and partially because the marginal or sketchy loans were supposed to be a minority fraction of the total fund. The theory was if subprime loans were packaged with normal loans the latter would carry the former. The trouble was the math simply didn't work at the levels of subprime loans foisted on the market through the machinations of the CRA.

In fact, elimination of the regulatory and market safeguards that were in place before the Clinton Administration and its Democrat Congress decided they could mold and direct the free market with artificial rules is the most significant part of the subprime mess. The safeguards were two-fold: first they were found in the partitions, erected in the 1930s as a result of Depression-era economic woes, between banks, investment houses, and insurance companies. The Glass-Steagall Act [passed 1933, repealed 1999] prevented banks from gambling with depositor's money through prohibitions against engaging in investment operations. This entire arena was overseen by 4 regulatory agencies-the Federal Reserve, the Securities and Exchange Commission, the Comptroller of the Currency, and the Federal Deposit Insurance Corporation. These decades-old government bureaucracies regulated private sector funds in order to prevent, among other things, manipulation of the market. What the Clinton Democrats actually delivered, as they maneuvered around the barriers overseen by these agencies, and then dismantled the agencies themselves (acts even House of Representatives Speaker Nancy Pelosi wrongly attributed to the Bush Administration), was a lack of understanding of free-market economics, of risk, of the need for transparency that allows everyone, including the government and the consumer, the ability to assess what is happening.

The second safeguard the Clinton cronies removed were the market generated and refined, over centuries, not just decades, controls embodied in risk assessment. Measuring risk is not a game, nor can it be governed by a synthetic set of rules that are manipulated for political or social purposes. Nor, when the numbers involved in the Fannie/Freddie segment of the mortgage industry are considered, is this a playground for the inexperienced-or, worse, the politically motivated. Risk can be evaluated, but when factual assessment is politically removed from a business equation, as it was when banks were forced to make loans based on political demands, virtually the only results that will obtain are both foolish and devastating.

The hubris of government, that because some official is in "control" they know either what they are doing, or what they are causing, allowed what was a bad idea (forcing banks to loan money to people who in all likelihood could not repay what they borrowed) to devolve into being a wholesale fiscal catastrophe-involving not just individual mortgages but the entire financial structure of the country. The sad fact (which resurfaces after every government failure) is that neither government regulators nor elected representatives are smarter, more dedicated, more insightful, or least of all, more experienced in economic matters or market reality simply because of the positions they occupy. Indeed, it is the lack of consequence for wrong, or even stupid, decisions they conjure (after all it is not their money with which they are dealing, so they have nothing at risk) that simply and factually makes them less adept in these matters than those who face the market itself.

At the center of the destruction of market rule in the lending field stood Bill Clinton, who is not ignorant of free market risk and reward, but is apparently far more enamored of political power than governing or economic sanity. He saw a political opportunity in the middle of his first term. The CRA was a good idea, but was constrained by legal and other niceties. Clinton did two things: he oversaw administratively implemented numerical quotas into CRA diversity ratings, and he pushed the CRA's statutory requirement of "safe and sound lending practices" to the back of the bus. He wanted a political result and he generated an economic disaster. And, to speak about this directly, it wasn't the law of unintended consequences taking effect, it was "damn the torpedoes, full speed ahead." Only problem was, the torpedoes circled around and hit the entire country and the entire economy 15 years on, long after Clinton's presidency had ended.

Through the political process Clinton-era bank regulators gained the muscle to control bank practices and behavior. They encouraged 3 schemes that seem, upon reading, simply insane: 1. no document loans (No Doc loans require no employment, income, or assets to be verified on a loan application. The only verification for the loan process was of the borrower's credit profile and the value of the property that was to stand as security for the loan), 2. no income loans (that meant loans could be made even though the lender did not or could not verify an income base that would allow repayment of the loan) and 3. loans made solely on the basis of race (that meant a bank's CRA rating would be solidified if not improved if the bank loaned to minority applicants, irrespective of credit-worthiness; the banks went along).

Even the Bush Administration was not immune to political pressure to make affordable housing a top priority and was fiscally irresponsible in its efforts to protect against politically motivated charges of racial bias. In January, 2004 the Department of Housing and Urban Development (HUD) put in place a program of "zero down payment" loans. The administration naively opined on announcing the program that "This action would help remove the greatest barrier facing first-time homebuyers-the lack of funds for a down payment on a mortgage." The legislation that was to be requested would eliminate the statutory requirement of a minimum three percent down payment. Calling a down payment a barrier is symptomatic of the rhetorical war that went on in Washington. Something that bars one from entering the game sounds like discrimination, something that is required by fiscal prudence obviously is discriminatory-but it is discrimination intended to protect all the participants, not to deny home ownership to some on the basis of bigotry or racism.

Ultimately these borrowers had no investment in the homes they were given, thus they had virtually no incentive to make sure they kept them, much less any understanding of how to do that.

It is to be noted that all subprime loans were not generated by banks, many were obtained from non-bank lenders, such as Countrywide Financial Co., a multi-billion dollar private mortgage company. The political apologists try to spread blame to supposedly greedy private lenders by offering "everyone was doing it, we didn't force it." They complain that lumping private lenders in with the banks is unfair, that the CRA didn't cover the non-bank market, thus their fiscal irresponsibility came solely from avarice. But, in practice, these companies were aggressively targeted by government regulators and community activists to make subprime loans. Countrywide was coerced into signing a HUD-generated document entitled "Declaration of Fair Lending Principles and Practices" that iterated the CRA's principles. By signing this declaration Countrywide was allowed to sell its mortgages to Fannie and Freddie. Without Countrywide's participation and signature on the declaration their loans generally would not have been eligible for large-scale secondary market repurchase, thus killing much of Countrywide's business.

The ultimate result was that the CRA's fanciful requirements were spread across the mortgage market in both direct and indirect fashion to banks and private lenders and had their effect in virtually all circumstances. Of course, Countrywide suffered just as the banks did when subprime loans began to fail and it was bankrupted and bought out in the process.

Fannie Mae and Freddie Mac and the Secondary Mortgage Market

Where and how Fannie and Freddie were brought to heel to force them to buy the highly risky subprime loans was relatively simple as well. Fannie and Freddie are the heart of the "secondary market," the place where mortgages created by banks and other lenders are re-sold. This is a huge business, and a profitable one, and we need to understand its energy in order to comprehend how Fannie and Freddie were politically manipulated and thus became complicit in removing economic restrictions on subprime loans in the secondary market.

The secondary market gives banks and private financial institutions an opportunity to repeatedly sell new mortgages on a relatively fixed amount of assets-an opportunity they wouldn't have if they didn't remove from their books most of the mortgages they create. The mechanics generally operate in this manner: a bank loans money to a borrower to buy a house. It takes back a mortgage. The security for the mortgage is the good faith intention of the borrower to pay the money back, the ability of the borrower to do that, and the value of the home on which the loan is made. If the value of the home goes down, or the borrower loses his job, the bank's security is lessened. In order to create a cushion for such an "unlikely" result, the banks have historically required a down-payment of the borrower's own funds-traditionally between 10% and 20%. If the home sells for $80,000, the borrower might have to put down $16,000 and the bank would finance the rest. The $16,000 the borrower is willing to invest in the home tells the bank a lot about this person as he or she walks in the door. The relationship fostered by each party's financial investment in the home creates a partnership and each has a strong incentive to make their bargain work.

But, once the bank gives the seller the $64,000 to complete the sale, it has depleted its assets and can't make any more income on like transactions because it has no funds-unless it re-sells the mortgage to a "secondary" financial institution. In this case, the bank may even sell the mortgage for $63,000 thereby apparently taking a $1,000 loss on the transaction. However, in making the loan in the first place, the bank would charge either closing fees, loan fees, application fees, origination fees, or points (a percentage of the mortgage's value paid to the bank for loaning the funds, usually about 1% of the mortgage amount) etc., that total more than $1,000. In reality the lender thus makes up all of its "loss" in re-selling the loan, and is ready to repeat the process. If it repeats it often enough the bank makes money and a lot of people get to own a home. In the subprime era it must also be remembered that a good portion of these charges and fees went to groups like ACORN and NACA, thus actually increasing the costs of the loan to the borrower and ensuring a greater financial burden on that person.

Government Supported Enterprises (GSEs)

The issue for the banks and private lenders, between 1977's CRA and the ascendancy of Bill Clinton to the White House, was how to sell to anyone the subprime loans they were individually being forced to make. These financial institutions were offering loans based on lowered credit/underwriting standards, loans they wouldn't have made save for the pressure of community organizations, powerful politicians, pro-active regulators, and the misguided misapplication of laws that didn't say what these groups said they meant. There was little question the lending industry knew from the beginning each of these loans was high-risk.

Initially Fannie and Freddie, being private, for-profit corporations, wouldn't buy these mortgages-they too knew unequivocally this business model was hazardous. To encourage a transformation at Fannie and Freddie Bill Clinton, through various agents and mechanisms, changed the purpose and integrity of the U.S. secondary mortgage market by altering the rules that governed this arena. This was a matter of politicians and sycophant bureaucrats not caring how risk is assessed but how federal power is brought to bear and election campaigns are won.

Briefly, Fannie Mae and Freddie Mac's basic function is to buy newly issued bank and other mortgages in order to help facilitate home ownership. As noted, when they take new loans off a lender's hands the lender can turn around and make even more loans. Fannie and Freddie, or more often, mortgage brokers/bankers working in tandem with both, bundle loans in a package. Fannie and Freddie purchase these loans either by issuing bonds that investors would buy on the open market like any other bond (termed "direct debt"), or by issuing "mortgage backed securities." In the latter case shares of stock in the bundled mortgages are sold and priced based on the value of the mortgages, their interest rate, term, etc. In this manner the bundle is turned into a "financial instrument." The stock and bond holders then collect the individual mortgage payments from the homeowner through a servicing agent.

(There are many other elements in this whole process, including reinsurance of Fannie/Freddie debt instruments by companies such as the now bankrupt American International Group (AIG), but these steps are mechanical consequences created as nervous participants tried to spread their risk. These efforts are not core to the causes being investigated here thus they are not evaluated in depth. However, it is understood that terms such as "credit default swap" and "financial derivative," among others, often distract and confuse lay observers trying to understand what happened to the financial instruments with which Fannie, Freddie, and others dealt. Although the terms themselves are not overly difficult to understand [search Wikipedia for articles that explain them in somewhat clear terms], how credit default swaps or derivatives actually function in the real world and how they can be turned six-ways from Sunday as they are implemented in highly sophisticated efforts to either insure investments or for speculative purposes, are topics not appropriate for this article for a simple reason: although the financial convolutions that took place at many levels made the runaway subprime mortgage business far more dangerous than it had to be [because if these avenues for risk dilution had not been available, everyone would have paid closer attention to what they were buying], all of those effects are consequences of the initial political maneuvering. It is the political aspects that ultimately caused so much fiscal and other devastation that must be kept in focus; the very complicated consequences found when everyone tried to protect themselves or make profits on uncertainty [which is what legitimate speculators do] could not exist but for the original political sin.)

In the early years, if banks concluded subprime mortgages they could not sell to Fannie and Freddie they were stuck with them. Without an ability to re-sell these mortgages the banks would realize substantially lowered income. They also had to bear the risk of default-the loss of the money they gave to the borrower to buy the home in the first place. So the banks initially fought back. No matter how much pressure was put on them, they would only lower their underwriting standards slightly; they simply wouldn't loan themselves into bankruptcy issuing mortgages that were highly risky-loans they had to keep on their own books. That meant that the community organizers had to get the rules changed at Fannie and Freddie so these two giants would buy these shaky mortgages. That meant politics, and corruption-intellectual, economic, social, political. The procedures and the content and the integrity of the mortgage industry had to be double-shuffled. This is where the subprime loan mess passed through adolescence and blossomed into not just adulthood, but into a malignant and felonious tyrant.

Why would Fannie and Freddie cave in to the destructive depredations of the activists, politicians, and regulators? If we recall that Fannie and Freddie were not, in that era, arms of the federal government, but quite successful private corporations, the steps to their own downfall can be clearly seen, no matter how irrational they ultimately appear. What the politicians did (remember, up until 1995 the Democrats controlled both houses of Congress) was to threaten these two successful secondary mortgage companies with ever more restrictive government controls on how they could operate and what would happen to their profits if they didn't agree to the lower underwriting standards.

To their credit, both Fannie and Freddie fought the changes until faced with legislative blackmail that would severely undermine their corporate operations, and which would be, at least initially, more difficult to live with than accepting and then re-selling a few marginal loans in the marketplace. The problem is the few marginal loans, once Fannie and Freddie were aligned as co-conspirators, became a Niagara of simply valueless paper. Had Fannie and Freddie taken the Democrat threat to the mat to see if they could make their case in Congress and with the financial community for a continuation of sound business practices, matters might have turned out differently. But, instead of being overseen by experienced business operatives who understood the risks and principles at stake, Fannie Mae, in particular, was taken over by Clinton political cronies who abetted the poor, even dangerous, business practices that Fannie was being asked to implement.

The free market, where business decisions are based on the facts of any given case, had initially held its own against the predations of the organizers. As well, the market could have absorbed the losses generated by those few loans that went bad based on the modestly reduced underwriting standards the activists initially, and locally, forced on the industry. If significant numbers of loans had begun to go bad, the bankers would have pushed back ever-harder against the community organizers, and a balance would have been regained.

However, when government agencies, such as Fannie and Freddie, seem to have the authority to back mortgage investments with the deepest pocket of all, the federal treasury, the idea of investor risk is removed. When we remove hazard the incentive to stop watching and to start feeding at the trough is 100%. In the case of the subprime madness, the lines between the private mortgage industry and government insurance blurred when government supported (not guaranteed) enterprises began purchasing billions, then trillions of dollars of home mortgages without any substantive understanding of the real value of the paper they were being forced to buy.

With supposed backing by the federal government, Fannie Mae and Freddie Mac bonds and securitized loans flew off the shelves into investor portfolios (foreign and domestic). Making matters worse was the ability of these GSEs, because of their very size, to obtain investment funds to finance these bundled mortgages at better rates than at-risk private firms. This allowed them, in turn, to back lower-rate mortgages and grow ever bigger, and much more profitable. Because of a false premise of government backing Fannie and Freddie products seemed AAA quality. Indeed some of their bonds were even rated AAA through highly questionable or even corrupt manipulation in the bond rating industry. When the whole scheme began to fall apart in 2008, the false premise of government backing became a real premise, as the politicians assured us was necessary.

Finally and perhaps saddest of all, the concentration of power in the two secondary-mortgage giants meant they were more easily manipulated by politicians and government overseers because fewer people had to be controlled-especially if those who needed to play along were administrators whom the politicians appointed in the first place. This factor alone ultimately caused as much of the problem as did the agency's supposed government backing.

Political Correctness from the Top Down

The crucial step in this 25 year process involved the inside players in Washington partnering with political correctness to create the perfect "third way" to solving some of America's minority issues. The overarching theory was this: if you give a person a home, you've created someone with an investment in his community and ultimately his country. It is a generic political goal with which one is initially hard-pressed to argue. Except there is a good argument against it: giving someone anything means they most often will not value it. In the case of the subprime borrowers it also meant the person being "given" a home they could not have qualified for under normal circumstances also did not likely understand the responsibility that came with it. Instead, they were led to believe they had a right to a home when what they really had was a right to earn a home. Initially the CRA was implemented to ensure the right to earn a home was not denied frivolously or discriminatorily. Eventually the Democrats attempted to re-constitute that right as another entitlement. Worst of all, the people supporting these schemes wished the latter to be true and their intention was to make everyone believe it was so. That they did this for political reasons, not out of altruism or even a sense of duty is a given.

What happened in the Clinton Administration was unconscionable political maneuvering designed to achieve politically correct goals that ignored, utterly, basic economics. It also ignored the rights of the rest of the citizenry upon whom the cost of this fiasco was being foisted. Andrew Cuomo, Clinton's last secretary at HUD, went so far as to claim that the administration was demanding an affirmative action bonus for minority mortgage applicants, as though economic risk assessment not only wasn't necessary, but didn't even exist. That minority homeownership had been wholly politicized became clear, and deadly.

What ultimately resulted should have been understood going in-if anyone had taken even a half-hearted look. Thus the explanation for why the Democrats and Clinton engaged in this bit of chicanery can only be understood in the continuing quest for power, in the continuing suborning of good (business and common) sense through the vehicle of political correctness (i.e., everyone is entitled to their own home), and in the apparent non-comprehension or disregard of free-market economics. If you twist the market one way, it acts like a balloon, it will pop out in some other direction in order to accommodate the pressure applied in the first instance. The market became so distorted as a result of political maneuvering the balloon has now popped out to crush much of the U.S. financial industry.

In retrospect it is clear that early in this era the banking community was serving the needs of the rising black middle class, but those who had not achieved that economic level did not fare as well, thus a political solution to a rational real-world economic circumstance was offered.

The practical result of Washington's political strategy was that originating banks and private lenders realized if Fannie and Freddie would buy marginal loans that slaked the thirst of the politicians and the community activists, the banks could avoid the risks of these loans by making and then re-selling them quickly. Even better, they got to keep the fees, points, and other charges they'd collected if the loan itself went bad. In the ultimate paradox, the more subprime loans these banks made, the more they wanted to make-profits in fees, charges, and points were rising with the new paradigm, and risk was gone.

Looking to short-term profits and not long-term stability the lenders ultimately became allies of ACORN and other like-minded organizations in the effort to get Fannie and Freddie to lower secondary mortgage standards. Once the barriers to making subprime loans were removed all the pieces were in place for the stability of the credit system to be challenged. All in the name of political correctness for political clients and political gain.

These many bad choices, generated from the supposed power of the 1977 CRA, perverted and distorted Fannie and Freddie's business decisions and allowed the act to be used as a politically-correct bludgeon; this would not have caused so many disastrous consequences had knowledgeable players been listened to. Several observers looked at the size of the program, its mechanisms, and the percentage of the U.S. mortgage market that it represented, and began to cry "foul." More on that in a moment.

The Appearance of Government Insurance

No investor knew the value of any individual mortgage that backed the stocks and bonds Fannie and Freddie were offering. There was no transparency. Why didn't investors care about this? Because the issuers of these collateralized stocks and bonds, Fannie Mae and Freddie Mac, were backed by the resources of the U.S. Government-or so everyone was led to believe. That this was not true became something that had to be true as Fannie and Freddie began to fail. Because of the size of the market-share these two GSE's represented, it was understood they could seriously harm the U.S. financial system if they collapsed; yet by default they also supposedly became too big to allow to fail. That this was not necessarily true, that the market could disassemble Freddie Mac and Fannie Mae in an orderly bankruptcy, as it had done during the half-trillion dollar savings and loan debacle in the 1980s, was something no one wanted to risk-politically first, and possibly economically later. It was easier just to blame capitalism and Wall Street than tell the truth.

That hard, difficult, but important lessons would be learned in an orderly disassembly of investments that did, in fact, have risks, but also had substantial underlying value, was ignored for a simple reason: it would be painful to those politicians who had supported and created the entire mess out of whole cloth. It was a confrontation between political players and private industry. That scared everyone inside the Beltway because there were ten bad things that could happen for every good one, and everyone saw an easy out-send the bill to the taxpayers. So they have.

Crony Capitalism

There is a final element that helps explain the full extent of the current failure of interventionist governance. It is called "crony capitalism," but it is better understood as phony capitalism. The term is newly minted and coined to describe some of the chicanery involved in the mortgage meltdown. Cronyism allowed the bureaucrats and politicians to line one another's pockets, obviously for less than altruistic purposes.

The effects of crony capitalism on Washington politics, enabled by control of Fannie and Freddie through political maneuvering and appointments, are important to understand. A few examples: according to an Investor's Business Daily article, "How a Clinton-era Rule Rewrite Made Subprime Crisis Inevitable" (9/24/2008), between 1989 and 2008 more than 380 politicians received contributions from officials at Fannie Mae and Freddie Mac. These two corporations spent more than $200 million on lobbying and political activities. For what purposes, to what end?

In 2003 Fannie Mae became embroiled in a financial scandal when its top officers conspired to overstate profits for personal gain (they were paid bonuses based on corporate performance). During the congressional investigation of this internal corruption officials at both Fannie and Freddie promised even more efforts in making minority subprime mortgage loans which delighted many in Congress and caused them to laud corporate sensitivity to this "problem." These political figures know little if anything about market economics or risk assessment-except the risk to re-election if they don't give the store away to right the wrongs of capitalists. Thus, they were bought off by the political bribe (more subprime loans), and then turned a blind-eye to the crooked financial arrangements that had come to light, and/or profited via their own campaign coffers, a particularly venal result.

Once the promise was made to effect more minority lending, the fact that the books had been cooked at Fannie was largely ignored by Congressional investigators; the players were reprimanded, but the real result-the continuation of substandard mortgage lending-was allowed because it was too politically valuable to kill, or even shed real light on. (How much in bonuses did Franklin Raines, the head of Fannie Mae and a Clinton appointee, receive on false numbers? Supposedly $100 million, much of which he was forced to give back when the scam was uncovered, but no jail time was suggested.) What happened at Fannie and Freddie (and further down the lending ladder) followed typical events where the incentive to cheat becomes too great. This open opportunity to theft is termed a "moral hazard" by the economists and philosophers who watch social norms implode.

The doubly bad result from the bogus and bloated income figures offered by the executives in charge was that Fannie Mae looked even more financially sound than it had when the lower, real figures were published. This, in turn, meant that making more subprime loans appeared even less risky than it actually was and misled almost everyone to continue to downplay any danger to the system. There were a few economists, bankers, members of the Bush Administration, and former regulators, all of whom knew and verified what they were seeing, who watched the game play out. Their cries warning of danger were termed either "wolf-like," or sour grapes, or ignorant, or alarmist-and they were almost universally discredited in much of the liberal press and by the politicians who were lining their pockets with Fannie/Freddie political payoffs.

Ultimately Fannie Mae and Freddie Mac controlled roughly 90% of the U.S. secondary mortgage market (about $5 ½ trillion in outstanding loans). Subprime mortgages, that comprised about $35 billion in 1994 when the floodgates were opened to this type of lending, fostered by the lowering of Fannie and Freddie requirements, rose to almost $1.5 trillion in 2007. If these institutions abruptly failed to make more loans a cascade of bad economic consequences would eventuate. If the loans that had already been made began to fail coincidentally, the cascade would have a catastrophic impact on the American economy; that is exactly what happened. With mortgage money gone, home buying, home building, home remodeling, home sales all disappeared, as did the thousands of supporting industries that depend on each of these elements. This is no small part of the American economy-actually it is the largest single sector. The current recession became inevitable.

Many of those within the political circles feared to call out the dangerous nature and breadth of the Fannie/Freddie bundling of subprime mortgages for fear of being labeled reactionary, if not racist. Others, particularly Republican congressmen who wanted to bring much of what was going on to the attention of the public were bullied, demeaned, and refused a stage by the leadership that controlled operations in Congress. Congressman Cliff Stearns (R-FL) was prevented from taking action by fellow Republican Speaker of the House Dennis Hastert when Hastert, in 2004, removed Stearns from responsibility for Fannie/Freddie oversight and Stearns found his hearings into their operations cancelled.

Finally, the agency set-up to monitor Fannie and Freddie (the Office of Federal Housing Enterprise Oversight, [OFHEO]) is subservient to the whims of Congress. Its funding has to have congressional approval each biennium whereas other financial oversight agencies get their resources from fees and dues paid by those over whom they exert authority. Although the latter funding ensures a continuous income stream and insulates the recipients from improper Congressional interference, it does not alleviate industry pressures-in other words there are not a lot of good choices when it comes to financing regulation. In the case of OFHEO, congressional bullying and threatening of the very regulators who should have been in charge of watching Fannie and Freddie was easily accomplished through the power of the purse, and oversight became timid in equal measure. Of course, as was observed earlier, many in Congress, including then Senator Barack Obama, received substantial contributions from those who wanted matters to continue as they had. Obama still ranks 2nd in contributions from Fannie and Freddie, and he was ever a staunch supporter of all negative aspects of the series of events that led to the 2008 fiscal catastrophe.

The banks at the center of the mortgage lending industry also feared government reprisals if they did not do as they were directed. Retaliation took the form of threats by regulators who could disallow bank expansion in an era where banks that did not engage in that game were doomed to be gobbled up by banks that were acting within the political paradigm. If a bank did not have a good CRA rating, which meant they were not a reliable low-income lender, the bank's reputation was substantially harmed-not just in the community but in the marketplace at large. No bank wanted to be known as antagonistic towards the less fortunate-so they negotiated the hoops. They thought they had no choice.

Those on the inside at Fannie and Freddie-well, they had the best incentive of all for not watching the books: government insured, politically backed profits. In this era political correctness shielded everyone from criticism. When the house of cards fell those on the inside had no qualms about pointing the finger at those supposedly prone to greed-the banks and investment firms who assuredly had played along. But the banks were secondary players-surely victims of greed, but only after the table had been set by the politically correct. When we remove risk from an investment it seems everyone just quiets down and grabs.

What is required?

To solve all these circumstances we do not, most decidedly, emphatically, and unequivocally, need more regulation designed to achieve results, to engage in social engineering. Those kinds of efforts are how and why we have arrived exactly where we are today. We do need, first, natural regulation; we need to re-insert risk and reward, transparency and credibility into the banking/mortgage business (and every other business where political ends override market control of taxpayer dollars).

Secondly we need regulation aimed at sound business practices-rules regarding bank liquidity, rules that ensure independent oversight of accounting and reporting practices, rules based in market realities that reflect fair asset valuation, etc.

The real problem with the bailout of Fannie/Freddie, among others, which was initially pegged at $700 billion despite the fact that virtually all shareholder value in these two firms has already been wiped out, is that it doesn't solve the problem, it treats the symptoms. Both firms are still able to make bad, even terrible loans. Both are being overseen by politically-connected executives. Both are now even more subject to political whims as wards of the government than they were before the financial meltdown. The bailout will also result in political influence being applied regarding the extension of credit.  A more undesirable result cannot be imagined. The only solution for the underlying problem is to allow real risk factors to control decisions. This brings us back to the initial situation-how do we then avoid "redlining?"

What we know is that we cannot eliminate the consequences of bad ideas (risk-free mortgage lending) with worse ones (risk-free mortgage lending when we know nothing is risk-free). That means that market-based mortgage decisions are not just a better idea than government enforced high-risk mortgages, they are mandatory. Redlining goes away the same way that all manner of discrimination in home buying or apartment renting or commercial leasing has been eliminated-by outlawing it. Lenders (private, public, or mixed) must be allowed to make decisions based on sound, fair, and open underwriting rules. Put a few folks out of business or in jail who violate these simple and open rules, and the rules will rule, and redlining will be a thing of the past-touted as real only by those who make their living through race-baiting and fear-mongering.

Barack Obama's comments have indicated that he clearly understands neither he nor anyone in his administration is smarter than the market. If he realizes nothing else, let us hope he realizes his, and government's, limitations. Who is in charge of running the economy? Nobody. As Wilhelm Ropke noted in his 1954 volume Economics of the Free Society, no one is in charge because, of course, everyone is.

The Federal Government Steps In, or Tries To

Now that most of the subprime mess is on the table the Chicken Littles claim a need for more regulation as they insist it was the market, the capitalists that failed. They will not hear and do not want to investigate any other potential (such as less interference in markets to allow them to reach their natural level), for if they do then it is possible facts will be discovered that do not fit their pre-arranged and loudly bugled conclusions.

Regulation is a tricky matter-it obviously can be manipulated for political purposes, or it can be ignored for political gain. In his last two years in office in the Clinton Administration (1999-2000) Larry Summers, Clinton's secretary of the treasury, (and now chair of President Obama's National Economic Council) warned of the dangers looming in the practices generated by Clinton's housing policies. Without intending to clutter this discussion with too much data, it is to be noted that between April 2001 and the middle of 2008, the Bush Administration on more than a dozen occasions called for substantially more oversight of the home mortgage market. They did this to counter what was happening as a result of political interference in this arena.

In testimony to Congress (April 2001 and February 2004) the administration called for reform of the capital requirements of Fannie and Freddie-meaning that neither entity had enough cash reserves to cover potential losses if subprime mortgages defaulted. It called for a new agency to oversee the operations of Fannie and Freddie because of lax and ineffective supervision by the existing Office of Federal Housing Enterprise Oversight (September 2003 and February 2004). The administration's fiscal officers (the secretary of the treasury, the head of the Office of Management and Budget, and the chair of the Council of Economic Advisors) warned repeatedly of potential disaster, and followed-through with suggestions for additional legislation to protect the U.S. financial system. They did this as they watched the danger of failure of Fannie Mae and Freddie Mac increase. Without political interference in the system that failure would not have happened-thus regulation, or any other solution-would never have been contemplated. The regulatory efforts offered were designed to counter this political interference…the professionals in this arena didn't miss anything, the politicians didn't understand anything.

The reaction of key Democrat members of Congress in this period is typical of the ignorance that resides in inexperienced, politically motivated, and uneducated elected representatives, who themselves were the cause of most of the mess. Following are but a few of the attacks on the Bush Administration's calls for reform and restructuring vis-à-vis Fannie and Freddie:

          September 2003, Congressman Barney Frank (D-MA): "Fannie Mae and Freddie
          Mac are not facing any kind of financial crisis….The more people exaggerate these   
          problems, the more pressure there is on these companies, the less we'll see in terms
          of affordable housing."
          April 2004, Congressman Barney Frank: Criticizing the Bush Administration and
          suggesting an "artificial issue" was being created, Frank commented "People pay
          their mortgages….I don't think we are in any remote danger here. This focus on
          receivership, I think, is intended to create fears that aren't there."
          July 2005, Senate Majority Leader Harry Reid (D-NV): "While I favor improving
          oversight by our federal housing regulators to ensure safety and soundness, we
          cannot pass legislation that would limit Americans from owning homes and harm
          our economy in the process." (Read that sentence again-it does say what you
          think it does.)

In a not surprising turn, both Barney Frank and Bill Clinton in early 2009 disavowed blame for anything placed on their doorsteps. In a public appearance February 17, 2009, Clinton declaimed, in opposition to a TIME Magazine article, that he did not do anything to cause the subprime economic meltdown. Frank penned a long blog dissertation that appeared on March 21, 2009 on how much he had wanted to help make things right, but was thwarted by the Republicans. What he didn't mention is how he and fellow Democrats made things wrong in the first place-that theirs was the original hubris, the original sin.

The Consequences

All of the tools implemented by the Democrats in the 1990s dramatically increased new home ownership among minorities, blacks in particular, but, unfortunately, to no real effect. Now that these loans are failing at unprecedented rates, minority ownership, falsely created, falsely backed, is dropping equally as quickly and may drop below former levels, before the politicians interfered. The damage done perversely ensures minority home ownership will remain at low levels for years to come-and that is the law of unintended consequences that, as always, took flight in innocence, and came home to roost laden with guilt (not gilt).

Fannie Mae and Freddie Mac invested so much money through the auspices of the CRA and the efforts of groups such as ACORN that by 2007 Fannie and Freddie owned, managed, or appeared to guarantee almost one-half of the $12 trillion U.S. mortgage market. And their half wasn't the good half. This exposure, when housing prices peaked and then began to decline, was too much for the market to carry.

It is important to note one of several other unintended consequences of politically-correct meddling in private enterprise. This effect was a primary cause of the housing bubble: home prices rose as subprime mortgages began to blossom-there was a frenzy, across the economic spectrum, to buy a house. As demand ate up supply, prices rose beyond the underlying value (the definition of a "bubble") of the remaining housing stock. The existence of low interest rates and ready money (further effects of unwise but politically effective government interference) strongly contributed to this event as well. When demand stopped as subprime loans began to sour, prices began to drop, then plummet. The fact is that if Fannie and Freddie were free market entities they would have faced restructuring or possibly dissolution as the loans that made up their portfolio began to default when prices began to fall. It was only through an implicit guarantee in the marketplace, that the government would back any Fannie/Freddie failure, they were allowed to prosper.

The ultimate result was never a failure of the free market, this was a failure brought on by the conceit of politicians who thought the market irrelevant and that they were both smarter and more powerful than whatever the market was. (This attitude is still front and center as misguided bailouts and stimulus packages fly through Congress.) The bailout of the banks itself causes panic in the credit market because of what it says about the system—that it cannot function without government interference, which leads to evermore ignorant government involvement.  The bogus stimulus plan is just as destructive of economic confidence, for the trillions of dollars will not and are not going to the private sector to rebuild jobs and tax revenues through economic growth.  As has been seen in dribbles and drabs these funds are going to pet interest groups to ensure their continued political support.  In other words, the entire series of steps is nothing more than politics as usual.  The subprime mess is and was the failure of interventionist political and administrative machinations, supported by a politically-correct philosophy that even today continues to defy economic reality. It is now clear, as it ever has been, that interventionism, like the socialism from which it takes its moral superiority, will succeed no better than its discredited forebear.

Where markets are in charge, where risk and reward and pain and penalty rule-the elements that capture any sane investor's full attention-the new regulatory power, designed to craft results by allowing government to meddle in the mortgage industry, could not have existed. When politicians and regulators are in charge, the outcome that ensued is virtually inevitable. Risk, with its proper role and iron-fisted rule, determines how business will be conducted. Had government power been restricted to its purported function-to define the rules of economic activity (basically the rules of contract law that foster a level playing field)-and had it not been allowed to grow to the point where it could also, without understanding much less heeding its own ignorance, demand outcomes, the subprime mess would never have eventuated.

When government subsequently engages in bailing-out failing or failed businesses, it simply shifts the risk of loss from those who owned and (poorly) ran those businesses to the taxpayers. There is a siphon from citizen wallets to corporate accounts. The worst of this is not just the money lost and given to financial institutions that violated all the rules, but the demand in the future for further government safeguards for irrational or irresponsible politically-motivated government-controlled business decisions.

Political Solutions

The answers being offered at this point (formerly by the last gasps of the Bush Administration and now through the supposedly fresh air of the Obama cohort) are wrong in virtually every measure. That is not unexpected. Although it is an axiom of politics that those who break the system should not be allowed to try to fix it, it is equally assured that is exactly what will happen so those folks can serve themselves first. What we see now is blame for the free market rather than the politicians who clearly and directly caused the subprime debacle, and fiscal punishment of the taxpayers.

As noted earlier, the first thing that happens in such a situation is that the political players take to the airwaves to deflect blame to others. The public listens but confusion mounts as the explanatory 2s the political class offers don't add up to comprehensible 4s. But, no matter, once the blame is shifted (in the minds of those doing the shifting) then the activity to "fix" what others supposedly broke proceeds at a blitz-like pace. Speed is claimed necessary because of the size of the problem-but it is really nothing more than a smoke-screen that precludes measured investigation. One plan after another is offered, but no time for reflection, consideration, adjustment, or understanding of long-term consequences is allowed; all the plans are swift on action and short on sense. (With regard to the trillion dollar "stimulus" package passed by Congress in February, 2009, it is noted that not one Congressperson or Senator read the 1400+ page bill before voting on it. That is not democracy, it is insanity or stupidity, or is it just politics as usual?)

In the situation at hand-where large sectors of the economy are in significant financial difficulty-the observation of Matthew Arnold in Culture and Anarchy comes to mind as we watch political actions outpace common sense: Our reactions demonstrate "…the old story that energy is our strong point and favorable characteristic, rather than intelligence." The politicians know that if they keep moving fast enough, forcefully enough, the public will tire of trying to keep up and will ultimately accept whatever is thrown out to the masses to "solve" the problem-even if the baby is hidden in all that bathwater. Arnold did not trust the political class; "No assumption is too unreal, no end is too unpractical for him….Perhaps they are the only class of responsible beings in the community who cannot with safety be entrusted with power."

There is a large sector of the American economy that is being penalized by the White House and Congressional responses: those individuals who are prudent, who saved through the housing boom instead of buying in a rising market where prices had clearly outstripped value, who invested wisely by avoiding subprime mortgage securities because they looked (and were) highly risky, who did not use their home's newly created equity as a slot machine to buy what they could not afford. These citizens are being punished by a hugely increased federal debt burden that will harm them and their children and grandchildren through increased taxation, increased interest rates throughout the private sector, inflationary economic consequences that devalue every single thing they own, and all because of the unrestrained profligacy of the imprudent, whom Congress now gives money to as though they are the ones who've been victimized.

The Congress and the president are going to "save" the banks and other financial institutions that behaved badly, even stupidly, because the moral hazard placed in front of these companies was too great to resist. In so doing they punish the banks that operated within the bounds of fiscal reality. What the government should do is let capitalism's equation play out as it is naturally designed-for profit and loss, success and failure. Instead of giving money to failed institutions to prop them up, which harms those that operated responsibly, the bad operators should be allowed to founder. There should be no government money devoted to this enterprise-that is the utterly wrong response.

In the right-side-up paradigm, the assets of bankrupt financial players would be bought up on the open market for the pennies on the dollar they are now worth, and they would, or would not, be made profitable again. Why allow those who participated in the collapse to have more funds, taxpayer funds? (When Lehman Bros. was allowed to go bankrupt in 2008 most of its assets that had value were purchased within 7 days.) Normal bankruptcy is the long-term responsible solution, even if there is short-term pain (though hardly any more than we have already experienced). Politicians hate public pain-it is their goal and mission in life to appear to prevent it, avoid it, remove it, (even if they cannot do that and even if what they do actually makes matters worse) so they can keep their jobs. And, in this case, because the trouble began within the confines of the political class itself, the current response is even more egregiously inappropriate than can be described in polite company.

What is truly devastating in the solutions being effected is the demand for ever more inappropriate regulation-that it was the lack of regulation that caused all this. The financial services industry is one of the most highly regulated in the country. It was not a lack of authority that caused the subprime mess, it was exactly the opposite, the ability of political players to maneuver by, through, over, and around regulatory authority to achieve political goals. Any new regulations will be equally sieve-like. One of the facts of life is that industries are good at cozying up to the agencies that regulate them. And once two players are cozy, corruption of every ilk becomes the rule, not the exception.

If those in Congress, who did virtually everything they could to destroy an industry in the name of "social justice," had just tried to steal the money, we all could have weathered that fairly easily-we've been doing it for centuries. But these people wanted something more important to them than money-they wanted power, and a mantel of prestige for supposedly doing good works, and they used the system in an attempt to gain both. With money one can do many things, with power one can do all things. And pretty much everything was done to the United States by the Democrat controlled Congress and White House in the case of the subprime farce.

The saddest fact of all is it wasn't that politicians ignored the reality of what they were doing that eventuated in 2008's fiscal implosion, they simply did not understand what they were causing from the start to the finish. What regulation aimed at results does, first and foremost, is offer a political opportunity to twist, and bend, and weave those very regulations to political purposes, to achieve political power. That is the only opportunity the people in Washington saw. The results speak for themselves-both as to why politicians shouldn't be allowed to meddle in the free market, and as to why offering morally suspect opportunities to the political class is just as dangerous, as P.J. O'Rourke observed, as offering the keys to the car and a fifth of whisky to teenagers.


The result of the first small efforts of the politically motivated to interfere with the laws of economics, to install in their own homes those folks whom they saw as politically useful, is that little good was accomplished-so many who were "given" the American dream have lost the homes they couldn't afford-and dramatic harm has been done to the somewhat innocent, the American taxpayer (not to mention the U.S. economy). I say somewhat innocent, for with very little effort on the part of the public the table could have been pulled out from under this entire shell game.

The economic fallout from the political arrogance must be directly noted. Without intervention in the housing market by the elected and appointed representatives, people whose economic comprehension of what they were doing was virtually non-existent, there would be no multi-trillion-dollar bailouts or stimulus packages, no recession, no counter-productive tax increases, no mass of new regulations that will do nothing but increase the size of government and suppress economic productivity. The first small step of supposedly politically-correct intrusion in the free market resulted in a slide down the slippery slope to world-wide almost cataclysmic financial repercussions. All of this was avoidable-it cannot be said any more simply than that.

While American democracy is supposed to be a participatory circumstance, it often isn't for a number of reasons: time; effort; personal concerns; lack of results, integrity, and faith; persistent disappointment-the list is long. Most voters do not pay attention to what our elected and appointed representatives do for us, much less to us. Both Thomas Jefferson and James Madison hoped the electorate would understand that its role was not completed when people laid their pencils down after marking a ballot. That was hope colored by the dedication and success of the revolutionary era.

Information about our governors that does invade the public's senses is mostly from mainstream media outlets, painted with a broad brush. On the surface the electorate often admires the political goals they see, and they move on in the hope or with the assumption the officials are doing what they say they will (without spending too much money). However, there is a certainty that makes this general impression hopelessly false: the intentional manipulation of both the press and the public by the political class-manipulation known as "spin," but more accurately called lying-whereby the political goals initially offered are changed, usually with some intellectual, political, or economic corruption apparent upon even casual observation. Punishment (at the polls or otherwise) for any of this is almost never in evidence, almost never even considered. The public's general inattention allows those who have individual incentives to manipulate the actual course of government through behind-the-scenes activities involving either or both Congress and the administration. In the case of the subprime fiasco fiscal and political manipulation was apparent throughout the U.S. mortgage industry between 1990 and 2008. The spin and lying were present in the beginning and are ongoing today.

There are two ways to circumvent these kinds of results-the first is citizen vigilance, which seems a meager possibility considering the reality of twenty-first century American life. The other is to prevent politicos from engaging in much of what they do; to limit the scope of government and to prevent them from intervening-with superficial claims of good intentions-in the lives of the populace in the first place. The words of Supreme Court Justice Louis Brandeis make the point best:

          Experience should teach us to be most on our guard to protect liberty when the
          Government's purposes are beneficent. Men born to freedom are naturally alert
          to repel invasion of their liberty by evil-minded rulers. The greatest dangers to
          liberty lurk in the insidious encroachments by men of zeal, well-meaning but
          without understanding. (Olmstead v. United States [1927])

Political intrusion is often justified as either desirable or necessary, or both. When the details are investigated, from thinking, to planning, to execution, to results, the people are often, very often, disserved in the process. This is so because of what Justice Brandeis observed: the political players may be well-meaning, but they are without understanding.

While intervention is one of the tools of governance, what happened in the case of the subprime mortgages is exactly the opposite of what is intended when government is called upon. Government is designed to keep play honest, to ensure no unfair advantage, to foster evenhanded and open competition, in other words, to set the rules of engagement. When it intervenes in this manner its actions serve its stated purpose; when it intrudes with political gain in mind-in other words, when it intends to foster results-it does not. The whole subprime episode and its myriad collateral consequences are a stark reminder that it is not free-market capitalism that failed us, it is government and political interventionism, coupled with public inattention that allowed what occurred.

The political notables think they are elected to act on behalf of…everyone. At least on behalf of everyone they judge deserving. And they do this with no apparent understanding or even familiarity with the laws of economics, human nature, or unintended consequences. The result of this hubris is that the notables turn out to need a bit of separation so we can see them more clearly: not able. As we observed earlier, it is a law: just because someone is elected or appointed to a position, it doesn't make them one whit smarter than they were the minute before they took the job. Yet, it is an equally immutable law that they almost always think they are-and they will use their new found power to prove that. That is a fundamental danger of open governance-giving power without any surety of sense in the person to whom it is entrusted.

Of course, the often arrogant response to being handed power, grounded in human nature, cannot rationally be seen otherwise-thus the Founder's limits on and separation of power; the checks and balances that supposedly mark power's containment; Madison's contention that ambition must be pitted against ambition to reign-in each. But even those tools won't work all that well; human beings are interminably clever-thus the only protection for the citizen is vigilance that results in government abstinence. In this circumstance Wheeler's Law needs to be observed for its common sense: "The way to end corruption in high places is to get rid of the high places."

Government abstinence, where the public sector does not act as every citizen's nanny, or wield power to engage in social engineering that ignores both personal choice and unintended consequences, is attained through the election process, whereby we place in office those who understand power-yet whom we still must watch vigorously. As Plato observed twenty-five hundred years ago, "No one who desires power is fit to wield it." Perversely, of course, most who run for office do desire power, and covet more of it with each electoral success that appears to justify its accretion. It is the unusual applicant who, rather than wanting to be someone, seeks simply to do something. If even just most of us watch those on whom we've bestowed power, such attention has a remarkably curative and curbing effect on the electoral process and the administration of government.

We've seen results similar to the subprime mess many times before. As Thomas Sowell commented some years back "History is mankind's painfully purchased experience, now available for free, or merely the price of attention and reflection." The taxpayers would do well to heed Dr. Sowell's advice, now and in strong measure, if what is facing the country is not to become even more devastating for generations to come.

This article first appeared in Conservative Battleline where it was titled Root of the Economic Crisis.

© 2/5/09

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